You and Senator Sherrod Brown have proposed an amendment that would cap the size of the largest banks and, in effect, break them up. How do you sell this to people who are leery of what seems like a radical move?

First off, we've broken up things before. We broke up Standard Oil, we broke up AT&T, we broke up the accountants, too. A lot of the changes we're talking about, the mergers, are just new. When you look at the reasons these banks are so big -- and you know how big they are -- remember the reason JP Morgan Chase is so big is because they bought Washington Mutual when it was in trouble, and Wells Fargo bought Wachovia, and Bank of America bought Merrill Lynch [during the crisis]. It is pretty straightforward, now that these are back on their feet, that it makes sense to break them up.

U.S. regulators should consider breaking up large financial institutions considered “too big to fail,” former Federal Reserve Chairman Alan Greenspan said.

Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations. That squeezes out competition and creates a danger to the financial system, Greenspan told the Council on Foreign Relations in New York.

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc.

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said.

Fed officials have suggested imposing a tax or requiring higher capital ratios on larger banks to ensure the firms’ safety and reduce some of the competitive advantage from the implied subsidy. Greenspan said that won’t work.

“I don’t think merely raising the fees or capital on large institutions or taxing them is enough,” Greenspan said. “I think they’ll absorb that, they’ll work with that, and it’s totally inefficient and they’ll still be using the savings”...

“If you don’t neutralize that, you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society,” he said.

“Failure is an integral part, a necessary part of a market system,” he said. “If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.”

Writing in the New York Times today, Joe Nocera sums up, “If Mr. Obama hopes to create a regulatory environment that stands for another six decades, he is going to have to do what Roosevelt did once upon a time. He is going to have make some bankers mad.”

Good point – but Nocera is thinking about the wrong Roosevelt (FDR). In order to get to the point where you can reform like FDR, you first have to break the political power of the big banks, and that requires substantially reducing their economic power - the moment calls more for Teddy Roosevelt-type trustbusting, and it appears that is exactly what we will not get.

Neither the draft bill, nor the Committee, nor anyone on the Hill having anything to do with financial regulation, is raising what I consider to be the two key reforms necessary for avoiding another financial meltdown -- resurrecting the Glass-Steagall Act that once separated commercial from investment banking, and applying antitrust laws to the remaining five biggest Wall Street banks so none is "too big to fail."

What's needed is a serious application of antitrust law to the financial-services sector and a speedy end to institutions that are "too big to fail."

***

[Geithner is proposing that] there should be a new "resolution authority" for the swift closing down of big banks that fail. But such an authority already exists and was used when Continental Illinois failed in 1984.

Indeed, even the FDIC mentions Continental Illinois in the same breadth as "too big to fail" banks.

And William K. Black - the senior regulator during the S&L crisis, and an Associate Professor of both Economics and Law at the University of Missouri - says that the Prompt Corrective Action Law (PCA), 12 U.S.C. § 1831o, not only authorizes the government to seize insolvent banks, it mandates it, and that the Bush and Obama administrations broke the law by refusing to close insolvent banks. And see this. Whether or not the financial giants can be broken up using the PCA, no one can doubt that the government could find a way to break them up if it wanted.

But the giant banks are not only dangerous because they skew the political system. There are five economic arguments against the mega-banks as well.

Impaired Competition

Fortune pointed out last February that the only reason that smaller banks haven't been able to expand and thrive is that the too-big-to-fails have decreased competition:

Growth for the nation's smaller banks represents a reversal of trends from the last twenty years, when the biggest banks got much bigger and many of the smallest players were gobbled up or driven under...

As big banks struggle to find a way forward and rising loan losses threaten to punish poorly run banks of all sizes, smaller but well capitalized institutions have a long-awaited chance to expand.

The Bank for International Settlements (BIS) is often called the "central banks' central bank", as it coordinates transactions between central banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

By failing to break up the giant banks, the government is guaranteeing that they will take crazily risky bets again and again and again.

We are no longer wealthy enough to keep bailing out the bloated banks. We have serious debt problems. See this, this and this.

(Anyone who claims that Chris Dodd's proposed "reform" legislation will prevent banks from getting bailed out again is wrong. If the giant banks aren't broken up now - when they are threatening to take down the world economy - they won't be broken up next time they become insolvent, either. And see this.)

Unfair Competition and Manipulation of Markets

Moreover, Richard Alford - former New York Fed economist, trading floor economist and strategist - recently showed that banks that get too big benefit from "information asymmetry" which disrupts the free market.

Nobel prize winning economist Joseph Stiglitz noted in September that giants like Goldman are using their size to manipulate the market:

"The main problem that Goldman raises is a question of size: 'too big to fail.' In some markets, they have a significant fraction of trades. Why is that important? They trade both on their proprietary desk and on behalf of customers. When you do that and you have a significant fraction of all trades, you have a lot of information."

Further, he says, "That raises the potential of conflicts of interest, problems of front-running, using that inside information for your proprietary desk. And that's why the Volcker report came out and said that we need to restrict the kinds of activity that these large institutions have. If you're going to trade on behalf of others, if you're going to be a commercial bank, you can't engage in certain kinds of risk-taking behavior."

The giants (especially Goldman Sachs) have also used high-frequency program trading which not only distorted the markets - making up more than 70% of stock trades - but which also let the program trading giants take a sneak peak at what the real (aka “human”) traders are buying and selling, and then trade on the insider information. See this, this, this, this and this. (This is frontrunning, which is illegal; but it is a lot bigger than garden variety frontrunning, because the program traders are not only trading based on inside knowledge of what their own clients are doing, they are also trading based on knowledge of what all other traders are doing).

Again, size matters. If a bunch of small banks did this, manipulation by numerous small players would tend to cancel each other out. But with a handful of giants doing it, it can manipulate the entire economy in ways which are not good for the American citizen.

But as Plaintiff's lawyer Michael Papantonio - suing BP concerning on behalf of fisherman and local businesses hurt by the oil spill - just revealed, Dick Cheney is partly largely responsible. As summarized by Eric at Daily Kos:

Mike Papantonio [said] An 'acoustic switch' would have prevented this catastrophe - it's a failsafe that shuts the flow of oil off at the source - they cost only about half a million dollars each, and are required in off-shore drilling platforms in most of the world...except for the United States. This was one of the new deregulations devised by Dick Cheney ...

49 out of 50 U.S. states are still showing less economic activity than a year ago, based on February 2010 coincident economic indicators from the Federal Reserve of Philadelphia. The chart below is organized from top to bottom, from the most growth in economic activity to the largest declines in economic activity.

***

North Dakota (ND) is the only state to currently have a higher level of economic activity year over year. Its February 2010 economic activity was 1.1% higher than February 2009, as shown by the green dot in the chart below.

***

Net-net what this tells us is that 49 out of 50 state economies are still underwater on a one year basis, and 28 out of 50 are even still falling vs. November.

We’re writing to invite you to join us as cosponsors of legislation to restrict the leverage and size of the very largest banks and financial institutions in the United States.

The resolution powers in the financial regulatory reform bill that passed the House last year represent critical first-steps in addressing the problem of risk-taking by institutions that are “too big to fail.” But it has become increasingly clear that to make absolutely certain U.S. taxpayers are never again forced to rescue a giant financial institution, we must make sure that no market participant is so large that a failure would result in economic collapse.

The six largest U.S. banks today have total assets estimated to be in excess of 63 percent of our national GDP. The gigantic size of megabanks, and the perception in the marketplace that they are indeed too big for the government ever to permit them to fail, gives them a competitive advantage over smaller financial institutions that distorts the market and discourages competition. The lack of competition in the banking industry, in turn, leads to ever-higher levels of risk in the system.

There is no evidence that giant financial institutions perform any public service or market function that cannot be performed as well or better by smaller, and even substantially smaller, banks and financial institutions. To the contrary, all the evidence suggests that megabanks distort the market and impose substantial risk to the public. Further, the unprecedented size of the largest banks gives them enormous political power, including the ability to thwart appropriate financial regulation. As former Secretary of Labor Robert Reich correctly observed in a recent column, “the only competitive advantage to being a giant bank headquartered on Wall Street is to have the economic and political clout to get bailed out by American taxpayers when the next crisis hits.”

The SAFE Banking Act of 2010 would limit the size of megabanks by prescribing statutory limits on deposits, non-depository liabilities, and leverage. These steps would require several of the largest banks to, in effect, break themselves up to come in under the limits that this law would create. Specifically, the bill would:

• Impose a strict 10 percent cap on any bank-holding-company’s share of the United States’ total insured deposits;

• Reduce the maximum amount of non-deposit liabilities at financial institutions (to two percent of United States GDP for banks, and three percent of GDP for non-bank institutions);

• Set into law a six-percent equity minimum for bank holding companies and selected nonbank financial institutions, ending the extreme leverage that puts at risk the solvency of the entire financial system.

For more information about the SAFE Banking Act, or to become a cosponsor, please contact [removed for privacy] in Rep. Miller’s office.

Sincerely,

Brad MillerBen ChandlerKeith EllisonSteve Cohen [Members of Congress]

[Robert Reich's article "Break Up the Banks" is attached to the letter]

I believe that physical gold is a reasonable investment right now based on the following factors: 1) sovereign defaults; 2) shortages of physical deposits; 3) the dollar; 4) central banks; 5) declining production; 6) inflation; 7) deflation; 8) uncertainty and distrust in government; and 9) flight to safety.

Gold hit a 2010 high above $1,180 an ounce in Europe on Friday, fueled by euro strength and investors continuing to embrace the metal's safe-haven properties on unease over euro zone sovereign debt levels.

The governments of every developed economy will eventually default on their sovereign debts, so the one thing he will never do in his life is 'sell my gold.'

Potential defaulter include the US, the UK and Western Europe.

Speaking to CNBC in a live interview via telephone, Faber said: "In the developed world we have huge debt to GDP, in terms of government debt to GDP and unfunded liabilities that will come due."

"These unfunded liabilities are so huge that eventually these governments will all have to print money before they default," he added.

Similarly, Nouriel Roubini said today that sovereign defaults could lead to inflation:

Nouriel Roubini, the New York University professor who forecast the U.S. recession more than a year before it began, said sovereign debt from the U.S. to Japan and Greece will lead to higher inflation or government defaults.

As discussed below, inflation is usually considered bullish for gold prices. And defaults would lead to uncertainty and increased distrust in government, which are bullish as well.

Omnis' Jim Rickards, GATA's Adrian Douglas and others have demonstrated that the big bullion dealers and ETFs don't have nearly as much as physical bullion as they claim.

Should a substantial portion of investors in these vehicles demand physical delivery at the same time, it could cause a panic in the gold market which would cause a huge run up in gold prices.

The Dollar

While the inverse correlation between the dollar and gold occasionally breaks down, it usually holds true. As Jonathan Ratner notes:

Those that follow the gold and currency markets know that the price of bullion and the U.S. dollar typically move in opposite directions. However, this negative correlation can turn positive from time to time and is happening now.

***

Historically, episodes of U.S. dollar appreciation coupled with rising gold prices tend to be fleeting, according to Stéfane Marion, chief economist and strategist at National Bank Financial.

In a note to clients he wrote, "...we still think that the historical negative correlation between gold and the greenback will resume once the uncertainty is lifted about the introduction of credible loan programmes between eurozone partners to help certain members reduce their fiscal deficits."

***According to Deutsche Bank, gold has decoupled from the dollar since at least the end of March.

Jim Rickards argues that the dollar will eventually be devalued to half of its current value, so that America can afford to service its debt (a declining dollar means that America's debt can be paid back in cheaper dollars, so the debt costs less in real terms).

While the dollar might rally in another stock market crash, the long-term trend of the dollar is strongly downward, favoring gold.

China, India, Russia and Other Gold Buyers

As Lawrence Williams wrote Tuesday, gold sales by central banks are virtually-nonexistent.

In fact, many central banks are buying large quantities of the shiny yellow metal.

Commentators such as Ambrose Evans-Pritchard and Byron King argue that China's hunger for gold will put a floor on gold prices. Specifically, they argue that China will "buy the dips" in gold prices, effectively putting a minimum on how low gold prices can go.

Indeed, former chief Merrill Lynch economist David Rosenberg argues that because China will buy a lot of gold, gold will shoot to $2,600/ounce.

China's gold demand is expected to double over the next decade due to jewellery consumption and investment needs, the World Gold Council (WGC) said in its first report on the world's fastest growing consumer of the metal.

***

If the central bank boosts gold holdings to 2.2 percent of forex reserves, a peak level seen in 2002, from the current 1.6 percent, China's total incremental demand would rise by 400 tonnes at the current gold price, the WGC report said.

China's share of global gold demand doubled from 5 percent in 2002 to 11 percent in 2009, and the council predicted that China's domestic gold mines could be exhausted within six years.

"The Chinese gold industry is simply not responding fast enough to bring in new supply," it said.

The world's biggest gold producer - Barrick - says that the relatively easy-to-reach gold supplies are gone, and so supplies are getting more and more expensive to locate and extract:

Aaron Regent, president of the Canadian gold giant [Barrick], said that global output has been falling by roughly 1m ounces a year since the start of the decade. Total mine supply has dropped by 10pc as ore quality erodes, implying that the roaring bull market of the last eight years may have further to run.

"There is a strong case to be made that we are already at 'peak gold'," he told The Daily Telegraph at the RBC's annual gold conference in London.

"Production peaked around 2000 and it has been in decline ever since, and we forecast that decline to continue. It is increasingly difficult to find ore," he said.

Global gold production has been in steady decline since 2002. Production in 2007 was around 2,444t, down 1% on the previous year.

Analysts note that virtually all of the low-lying fruit has now been picked with respect to gold, meaning that companies will have to take on more challenging and more expensive projects to meet supply. The extent to which the current high price of gold can translate into profits remains to be seen...

According to Bhavesh Morar, national leader of the mining, energy and infrastructure group with Deloitte Australia, frenzied exploration activity over the last few years has seen virtually all of the easy harvest been picked with respect to gold...

The high price of gold is however encouraging more adventurous projects, be they more challenging financially, geologically, geopolitically or all three. New projects for gold and other resources are mushrooming throughout Africa, China, the Middle East and the former Soviet Union; all areas where sovereign risk is potentially very high.

Miners have the same geological landscape to work with today as those miners thousands of years ago. The only difference is the low-hanging fruit has already been picked. Gold producers must now search for and mine their gold in locations that may not be very amenable to mining. Many of today’s gold mines are located in parts of the world that would not have even been considered in the past based on geography, geology, and/or geopolitics.

And these factors among many are attributable to an alarming trend we are seeing in global mined production volume. According to data provided by the US Geological Survey, global gold production is at a 12-year low. And provocatively this downward trend has accelerated during a period where the price of gold is skyrocketing.

You would think that with the price of gold rising at such a torrid pace gold miners would ramp up production in order to profit from this trend. But as you can see in this chart this has not been the case, at all. Not only has gold production not responded, but it has dropped at an unsightly pace that has sent shockwaves throughout the gold trade.

As the red line illustrates gold’s secular bull began in 2001, finally changing direction after a long and brutal bear market drove down prices to ridiculous lows in the $200s. To match this bull the blue-shaded area provides a picture of the corresponding global production trend. And you’ll notice that in the first 3 years of gold’s bull production was steady. This is not a surprise as you figure it would take the producers a few years to ramp up supply. But instead of supply increasing in response to growing demand and rising prices, it took a turn to the downside. And what’s even more amazing is the persistence of this downtrend. Since 2001 gold production is down a staggering 9.3%! In 2008 there were 7.7m fewer ounces of gold produced than in 2001.

Also in July, Whiskey and Gunpowder posted a chart on historical gold production, and argued for decreasing production:

Take a look at the chart below from Macquarie Research, depicting world gold production 1850-2008...

For example, look at the very steep rise in gold output during the 1930s. That was during the depths of the worldwide Great Depression.

In both the US/Canada (blue area), and the rest of the world (gray area), people were digging more and more gold. The Soviets (purple area) increased their gold output too, courtesy of Joseph Stalin and his Gulag. Desperate times call for desperate measures, I suppose. Will that sort of history repeat this time around?

Or look at that massive run-up in gold output from South Africa (green area) in the 1950s and 1960s. That was during a time when South Africa was instituting its post-World War II system of apartheid. Labor was cheap (sorrowfully cheap), and quite a lot of international investment poured into South Africa without moral qualm. The South Africans dug deep and just plain tore into those gold-bearing reef structures of the Witwatersrand Basin.

But notice how quickly the South African gold output declined in the 1970s, as the mines got REALLY deep and the rest of the world began to institute sanctions against South Africa over its apartheid system.

And then look at the Gold Price run-up that followed in the late 1970s. It was a time of inflation, mainly coming from the US Dollar. Yet world gold mine output was dropping as well. Falling output, plus monetary inflation? The Gold Price skyrocketed. Another bit of useful history, right?

Now let's focus on more recent history, since about 1990. There were large increases in gold output from the US/Canada (blue), Australia (gold) and Asia (China orange, non-China open bar). By 2000 or so – the world production peak – Gold Prices were down toward $300 per ounce and below.

But as the chart shows, in the past 10 years, gold output has shown a marked DECLINE in the major historic Gold Mining regions. The prolific gold output from the US/Canada, Australia and South Africa has followed downward trends. Sure, these regions still lift a lot of ore and pour a lot of melt. But the production trend is DOWN.

The US/Canada, Australia and South Africa all have well-established and (more or less) workable mining laws – despite the best efforts of many current politicians and regulators to screw it all up. These historically producing areas are politically stable. Overall, there's good mining infrastructure, with road and rail networks, power systems, refining plants, a vendor base, mining personnel and access to capital.

But that's not the case in many areas of the developing parts of the world. Political stability? Security? Infrastructure? Transport? Power? Refining? Vendors? Personnel? Capital? Everywhere is different, of course. But overall, the entire process is much more problematic. So there's a lot more risk. When you move away from the traditional mining jurisdictions, the whole process of exploration, development and mining is more expensive.

Thus, the new gold discoveries of the future are going to lack some (if not most, or perhaps all) of the advantages of the developed mining world. That means that the ore deposits of the future will have to offer much higher profit margins, based on size and ore grade, to compensate for the increased risks. Too bad Mother Nature (or Saint Barbara, who looks after miners) doesn't work that way.

It also means the timeline to develop the mines of the future will likely be stretched over many years while political, legal, bureaucratic, logistical and social issues are ironed out.

The key driver for the future of worldwide gold supply will be DECLINING output overall over time.

Of course, if the price of gold warrants ramping up, then production will increase. Just as with discussions about peak oil, the issue is not that the resource is totally running out, it is that it will be more and more expensive to extract.

John Paulson argues that gold is something you buy-and-hold for at least the medium term:

Paulson is convinced that gold will be a very good way to protect himself from the eventuality of currency debasement (i.e., inflation). He observed that if one thinks about gold in a three- or five-year time horizon (instead of hour to hour, day to day or week to week), the probability increases of gold being higher over time...

Deflation

If gold does well during times of inflation, it makes sense that it would perform poorly during deflationary periods.

But Examiner.com points out that such an assumption is probably untrue. Specifically, as Examiner.com writes:

Eric Sprott - who manages $4.5 billion in assets, and correctly predicted in March of 2008 a "systemic financial meltdown” - says:

“I believe no matter what environment you’re in - deflation or inflation - people will run to gold,” Sprott said. “Gold is proving exactly what we all would have expected, that in almost any environment, it’s a go-to asset.”

Investment analyst and financial writer Yves Smith argues that gold does well during both periods of deflation and high inflation. She argues:

Historically, gold does well [in] hyperinflation and deflationary [periods]. Gold does poorly under more normal conditions, and gets hammered in disinflationary conditions, a falling but positive rate of inflation.

Analyst Adrian Ash argues that gold's value actually increases during periods of deflation even if its price drops:

Absent the money-supply limits which the gold standard imposed on the world, people rightly guess that double-digit inflation would prove rocket-fuel for the bull market in gold. Yet the purchasing power of gold nearly doubled during the Great Depression, and it’s risen four-fold during this decade’s low consumer-price inflation as well.

Why? Because both those periods of low price-inflation saw the money-issuing authorities devalue the currency, first with explicit reference to gold but now without daring to name it. Roosevelt in the mid-30s slashed the dollar’s gold content by 40%; the Greenspan/Bernanke Fed devalued the Dollar again to sidestep a DotCom Depression, keeping real interest rates at less than zero, between 2002-2005.

The maestro’s apprentice applied the same trick in the back-half of 2008, but so far to no avail. And now even the European Central Bank is pumping out money – a near half-trillion euros today alone – in a bid to revive bank lending, swamp the currency markets, and pull Germany out of its first flirt with deflation since the 1930s.

Just such a devaluation – and again, absent any stated reference to gold – was attempted by the Bank of Japan a little less than a decade ago.

Indeed, Japan is the only developed nation since the end of the gold standard to have suffered an extended deflation in prices. So far, at least. Germany and Switzerland look set to try for a re-wind, and unless the dollar can outpace the euro’s descent, we might yet see truly sub-zero inflation in the United States, too.

But whatever that should mean for gold prices, all other things being equal, just doesn’t matter. Because the gold price will not get a chance. All other things are not equal, and the policy solution – rank devaluation – can only make gold more appealing to investors and savers, whether the “monetarist experiment” of TARP, quantitative easing or a half-trillion euros proves successful or not.

Japan’s slump into deflation coincided with the Bank of Japan’s “zero interest rate policy” (ZIRP) at the start of this decade. It also saw the gold price worldwide hit rock-bottom and turn higher, a move that analysts (including us) have typically linked to US monetary moves and investment cash looking for safety as the Dotcom Bubble exploded.

But zero-rate money from the world’s second-largest economy shouldn’t be ignored. And today, zero-rate money is all the developed world has to offer – a trick that might not beat deflation, but might just spur a whole new rush into gold.

In other words, Ash argues that you can't take inflation or deflation in a vacuum. During deflationary periods, governments always increase the money supply with a flood of new dollars, which is bullish for gold.

And economist Marc Faber wrote in October 2007 that gold will do well even in a deflation:

How would gold perform in a deflationary global recession? Initially gold could come under some pressure as well but once the realization sinks in how messy deflation would be for over-indebted countries and households, its price would likely soar.

Therefore, under both scenarios - stagflation or deflationary recession - gold, gold equities and other precious metals should continue to perform better than financial assets.

Is Faber right?

Well, take a look at the following charts showing gold's performance as compared to the yen during Japan's "lost decade" of deflation:

If you study the above chart, you will see that gold seems to often fall during the beginning stages of a recession, then rise in the later stages of the recession (before 1971, the dollar was still backed by gold at a fixed price, and so gold did not fluctuate).

After five years in a deflationary economic wilderness, the Bank of Japan switched during the spring of 2001 to a policy of quantitative easing--targeting the growth of the money supply instead of nominal interest rates--in order to engineer a rebound in demand growth.

Look again at the first gold chart for Japan, above.Gold appears to start increasing against the Yen in 2001.

This may provide some evidence for Ash's thesis that it is an expansion of the money supply which pushes the price of gold up in the later stages of deflationary periods.

See also Fred Sheehan's summary of Roy Jastram's study of the performance of gold during deflationary periods throughout history.

The gold price ... is trending higher in U.S. dollar terms and surging in Euro terms and is a hedge against financial instability.

Chris Martenson argues that - in prolonged periods of deflation - we usually see failures of large and significant banks, institutions, and perhaps even states and countries. (Because gold traditionally does well during periods of uncertainty, Martenson likes gold during periods of deflation).

Short-term rates of 0% are bullish for gold, which serves as a store of value but is a useful hedge against deflation as well, since deflation is inherently destabilizing for financial assets. In the 2001-03 deflationary period, gold rose more than 30%, not to mention the prospect of a return to a dollar bear market. "Gold is inversely correlated to global short-term interest rates and there is a race right now towards 0%. Production is down 4.0% y/y while fiat currencies globally are being created at a double digit rate by the world's central banks....As for all the talk of a 'gold bubble,' it would take a nearly 625% surge in gold to over US$6,000/oz and a flat stock market to actually get the ratio of the two asset classes back to where it was three decades ago when bullion was in an unsustainable bubble phase."

Gold tends to be less sensitive to global economic slowdown than industrial metals or energy and works better as a hedge against crisis than inflation.

(If global short-term interest rates rise, that would obviously be bearish for gold.)

The grand old man of the New York Federal Reserve bank’s gold department, the last Mohican, John Exter explained the devolution of money (not his term) using the model of an inverted pyramid, delicately balanced on its apex at the bottom consisting of pure gold. The pyramid has many other layers of asset classes graded according to safety, from the safest and least prolific at bottom to the least safe and most prolific asset layer, electronic dollar credits on top. (When Exter developed his model, electronic dollars had not yet existed; he talked about FR deposits.) In between you find, in decreasing order of safety, as you pass from the lower to the higher layer: silver, FR notes, T-bills, T-bonds, agency paper, other loans and liabilities denominated in dollars. In times of financial crisis people scramble downwards in the pyramid trying to get to the next and nearest safer and less prolific layer underneath. But down there the pyramid gets narrower. There is not enough of the safer and less prolific kind of assets to accommodate all who want to "devolve”. Devolution is also called "flight tosafety”.

(Click here for full image; I can't vouch for the accuracy of the rankings for all of the levels . . . for example, muni bonds versus corporate bonds)

Last September, Alan Greenspan lent some support to the theory. Specifically:

Gold prices that jumped above $1,000 an ounce this week are signaling that investors are buying metals to hedge against declines in currencies, former Federal Reserve Chairman Alan Greenspan said.

The gains are “strictly a monetary phenomenon,” Greenspan said today at an investment conference in New York. Rising prices of precious metals and other commodities are “an indication of a very early stage of an endeavor to move away from paper currencies,” he said...

“What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,” Greenspan said.

In other words, Greenspan is saying that investors are moving out of the second-to-lowest step on the pyramid (currencies and government bonds) and into the lowest step (gold).

Greenspan is also verifying what goldbugs like Exeter, Fekete and Schoon have been claiming: that "the barbarous relic" still holds an important place in the modern investor's psyche.

Indeed, Tyler Durden and David Goldman argue that the response of investors to the PIIGS' debt crisis shows that Exeter is right, and that the shift from currencies to gold is already occurring.

Only time will tell if they are right.

Note: I am not an investment advisor and this should not be taken as investment advice.

The Bank for International Settlements (BIS) is often called the "central banks' central bank", as it coordinates transactions between central banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

The leading monetary economist told the Wall Street Journal that this was not a liquidity crisis, but an insolvency crisis. She said that Bernanke is fighting the last war, and is taking the wrong approach (as are other central bankers).

Nobel economist Paul Krugman and leading economist James Galbraith agree. They say that the government's attempts to prop up the price of toxic assets no one wants is not helpful.

BIS slammed the easy credit policy of the Fed and other central banks, the failure to regulate the shadow banking system, "the use of gimmicks and palliatives", and said that anything other than (1) letting asset prices fall to their true market value, (2) increasing savings rates, and (3) forcing companies to write off bad debts "will only make things worse".

Remember, America wasn't the only country with a housing bubble. The world's central bankers let a global housing bubble development. As I noted in December 2008:

And the bubble in commercial real estate is also bursting world-wide. See this.

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Moreover, the real estate bubble formed the base upon which a series of bubbles in derivatives were built. Specifically, mortgages were packaged in "collateralized debt obligations" (CDOs), which were sold in enormous volumes all over the world. Credit default swaps were then bet against the companies which bought and sold the CDOs.

Now, with housing prices crashing, the CDO bubble is crashing, as is the CDS bubble.

A series of other derivatives bubbles are also crashing. For example, the "collateralized fund obligations" - sort of like CDOs, but where the assets of a hedge fund are the asset being bet on - are getting creamed as hedge funds are forced to sell off many hundreds of billions in assets to cover margin calls.

As everyone knows, the size of the global derivatives bubble was almost 10 times the size of the world economy. And many areas of derivatives are still hidden and murky.

So the bust of the derivatives bubble could even be bigger than the bust of the housing bubble.

BIS also cautioned that bailouts could harm the economy (as did the former head of the Fed's open market operations). Indeed, the bailouts create a climate of moral hazard which encourages more risky behavior. Nobel prize winning economist George Akerlof predicted in 1993 that credit default swaps would lead to a major crash, and that future crashes were guaranteed unless the government stopped letting big financial players loot by placing bets they could never pay off when things started to go wrong, and by continuing to bail out the gamblers.

These truths are as applicable in Europe as in America. The central bankers have done the wrong things. They haven't fixed anything, but simply transferred the cancerous toxic derivatives and other financial bombs from the giant banks to the nations themselves.

Private banks don't make loans because they have extra deposits lying around. The process is the exact opposite:

(1) Each private bank "creates" loans out of thin air by entering into binding loan commitments with borrowers (of course, corresponding liabilities are created on their books at the same time. But see below); then

(2) If the bank doesn't have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It's not just Bernanke ... the central banks and their owners - the private commercial banks - have been running the printing presses for hundreds of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve requirements in the U.S. If Bernanke has his way, American banks won't even have to borrow from the Fed or other banks after the fact to have reserves. Instead, they can just enter into as many loans as they want and create endless money out of thin air (within Basel I and Basel II's capital requirements - but since governments are backstopping their giant banks by overtly and covertly throwing bailout money, guarantees and various insider opportunities at them, capital requirements are somewhat meaningless).

The system is no longer based on assets (and remember that the giant banks have repeatedly become insolvent) It is based on creating new debts, and then backfilling from there.

It is - in fact - a monopoly system. Specifically, only private banks and their wholly-owned central banks can run printing presses. Governments and people do not have access to the printing presses (with some limited exceptions, like North Dakota), and thus have to pay the monopolists to run them (in the form of interest on the loans).

At the very least, the system must be changed so that it is not - by definition - perched atop a mountain of debt, and the monetary base must be maintained by an authority that is accountable to the people.

This is not now about Greece (with 2 year yields reported around 20 percent today) or Portugal (up 7 basis points) or even Spain (2 year yields up 27 basis points; wake up please) or even Italy (up 6 basis points). This is no longer about an IMF package for Greece or even ring fencing other weaker eurozone economies.

This is about the fundamental structure of the eurozone, about the ability and willingness of the international community to restructure government debt in an orderly manner, about the need for currency depreciation within (or across) the eurozone. It is presumably also about shared fiscal authority within the eurozone – i.e., who will support whom and on what basis?

(In related news, Eurozone sovereign credit default swaps widened somewhat Tuesday, but tightened again after the German finance minister said that Germany will rush through a disbursement of funds to Greece.)

Portugal’s stock market has traded down to a 12-month low and it’s so bad in Greece that the government has banned short selling for two months. (Hey, it worked in the once-capitalistic U.S.A. didn’t it?) We see in the NYT that Barclay’s analysts believe that Greece needs €90 billion to see them through, €40 billion for Portugal and €350 billion for Spain!That is €480 billion of refinancing help, which dwarfs the latest €45 billion EU-IMF joint aid announcement by a factor of TEN (according to Ken Rogoff, the IMF is maxed out after €200 billion)! Do euros grow on trees as fast as Bernanke-bucks? Would the ECB, modeled after the Bundesbank, ever resort to the printing press for a fiscal bailout? Where exactly is this money going to come from?

***

Yesterday was really as much, if not more, about Portugal than it was about Greece. Contagion risks are spreading as they were amidst the turmoil around Bear Stearns in early 2008 ...

[Spain's] combined fiscal and current deficits are the highest in the industrialized world, save for Iceland (and we know what shape it is in). The amount of debt it has to refinance in the coming year is as large as the entire Greek economy ...

***

If the other two major rating agencies follow S&P’s lead and cuts Greece to “junk”, then the ECB would be in a real bind for it cannot hold below-investment-grade bonds on its balance sheet. If the ECB does accept junk-rated Greek debt as collateral, then the sanctity of its balance sheet will be seriously undermined; though this ostensibly didn’t matter too much to the Fed in the name of saving the system.

Nouriel Roubini says “in a few days there might not be a eurozone for us to discuss.”

It is tempting to assume that this is just a European problem. But that might be a very erroneous assumption. See this, this and this.

The most terrifying words I've seen written so far about the growing crisis in Greece were penned by Yves Smith yesterday: "So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU's erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on."

The Great Depression was composed of two separate panics. As you can see from contemporary accounts--and I highly recommend that anyone who is interested in the Great Depression read the archives of that blog along with Benjamin Roth's diary of the Great Depression--in 1930 people thought they'd seen the worst of things.

Unfortunately, the economic conditions created by the first panic were now eating away at the foundations of financial institutions and governments, notably the failure of Creditanstalt in Austria. The Austrian government, mired in its own problems, couldn't forestall bankruptcy; though the bank was ultimately bought by a Norwegian bank, the contagion had already spread. To Germany.... It's also, ultimately, one of the reasons that we had our second banking crisis, which pushed America to the bottom of the Great Depression, and brought FDR to power here.

As U.S. cities and towns wrestle with financial problems, investors are finding a new way to profit on their misery: by buying derivatives that essentially bet municipalities will default.

These so-called credit default swaps are basically insurance contracts that have long been available to protect holders of corporate bonds against default. They became available a few years ago for municipal debt, allowing investors to short sell—or bet against—countless cities, towns and bridges, and more than a dozen states, including California, Michigan and New York.

The derivatives are still thinly traded, but their existence has the potential to make investors skittish

Offered by banks like JP Morgan, Bank of America, and Citigroup, the so-called municipal credit default swaps can be used by investors to bet that insurance contracts protecting holders of municipal bonds will default.

Some states say the derivatives not only scare away potential buyers of municipal bonds by creating a perception of risk, but ultimately drive up states' borrowing costs. Others contend that the instruments are traded too thinly to affect municipal bond markets or a state's credit rating.

The California treasurer is just one of a number of state treasurers that have launched a probe into the sale of these derivatives and the sale of municipal bonds by big Wall Street firms that might reveal "speculative abuse of CDS in the muni market," says one regulator.

Of course, if states or cities go bust, Uncle Sugar will need to bail them out.

So by letting the bailed out gamblers on Wall Street run amok, Summers, Geithner, Bernanke and the gang are increasing the odds that the states and cities of America - you know, the actual constituent parts which make up the United States - will need to be bailed out.

In an interview with The Australian Women's Weekly, Bishop Robinson [the former auxiliary bishop of Sydney] says boys suffered more than girls at the hands of pedophile priests partly because they were more available to them, with nuns tending to play a greater role in the religious education of young girls.

There was also a view among some offenders with whom he had worked that a priest's celibacy vows weren't broken if a boy was involved.

"We've met it often enough to see it as a factor," he tells the magazine, out today. "That's what the vow of celibacy refers to, being married. If it's not an adult woman, then somehow they're not breaking their vow."

In other words, some priests justify pedophelia by convincing themselves that molesting kids doesn't violate their vows of celibacy.

Bishop Robinson was himself sexually abused as a boy, and so he is more willing to speak out than many.

In economics, austerity is when a national government reduces its spending in order to pay back creditors. Austerity is usually required when a government's fiscal deficit spending is felt to be unsustainable.

Development projects, welfare programs and other social spending are common areas of spending for cuts. In many countries, austerity measures have been associated with short-term standard of living declines until economic conditions improved once fiscal balance was achieved (such as in the United Kingdom under Margaret Thatcher, Canada under Jean Chrétien, and Spain under González).

Private banks, or institutions like the International Monetary Fund (IMF), may require that a country pursues an 'austerity policy' if it wants to re-finance loans that are about to come due. The government may be asked to stop issuing subsidies or to otherwise reduce public spending. When the IMF requires such a policy, the terms are known as 'IMF conditionalities'.

Wikipedia goes on to point out:

Austerity programs are frequently controversial, as they impact the poorest segments of the population and often lead to a wider separation between the rich and poor. In many situations, austerity programs are imposed on countries that were previously under dictatorial regimes, leading to criticism that populations are forced to repay the debts of their oppressors.

What Does This Have to Do With the First World?

Since the IMF and World Bank lend to third world countries, you may reasonably assume that this has nothing to do with "first world" countries like the US and UK.

But England's economy is in dire straight, and rumors have abounded that the UK might have to rely on a loan from the IMF.

Al Martin - former contributor to the Presidential Council of Economic Advisors and retired naval intelligence officer - observed in an April 2005 newsletter that the ratio of total U.S. debt to gross domestic product (GDP) rose from 78 percent in 2000 to 308 percent in April 2005. The International Monetary Fund considers a nation-state with a total debt-to-GDP ratio of 200 percent or more to be a "de-constructed Third World nation-state."

Martin explained:

What "de-constructed" actually means is that a political regime in that country, or series of political regimes, have, through a long period of fraud, abuse, graft, corruption and mismanagement, effectively collapsed the economy of that country.

The IMF is - in fact - now saying that the U.S. must live more austerely.

In the lingo of the International Monetary Fund, the future of the world hinges on "rebalancing and consolidation," antiseptic words that would not seem to raise a fuss.

***

But the translation is a bit ruder, something on the order of: "Suck it up. The party's over."

To keep the global economy on track, people in the United States and the rest of the developed world need to work longer before retiring, pay higher taxes and expect less from government. And the cheap imports lining the shelves of mega-chains such as Wal-Mart and Target? They need to be more expensive.

That's the practical meaning of a series of policy papers and statements issued in recent days by IMF officials, who have a long history of stabilizing economies and solving global financial problems, as they plot a course to keep the world economy growing and reduce the risk of another "great recession."

***

It means a pretty serious reworking of expectations in the developed world: changes in labor rules, product prices, currency values and even the social contract between governments and an aging citizenry.

"It is not that living standards will lower, but they will not increase as fast as they have been," said Domenico Lombardi, a former IMF executive director. The ideas being discussed by world leaders "are coded words," he said. "They don't like words like 'imposing higher taxes' and 'cutting spending.' "

***

The level of the correction needed is large, perhaps 10 percent of gross domestic product. In the United States, that would amount to roughly $1.4 trillion annually, to be cut from government programs or raised through new taxes.

The IMF, which in recent years had become largely an advisory body to nations in crisis, will now be charged with aggressive monitoring of the global economy. Underscoring that role, Treasury Secretary Timothy F. Geithner said yesterday that Washington had consented to a rigorous IMF review of the U.S. financial system for the first time since the fund was created at the end of World War II.

And the IMF's currency - Special Drawing Rights (SDRs) - may become the world's reserve currency. See this and this.

And some say that the IMF will become the world's central bank.

According to Jim Rickards - director of market intelligence for Omnis - the purpose of the G20 Summit in Pittsburgh on September 24 was as follows:

The IMF is being sort of anointed as a global central bank.

Rickards also said that the plan is for the IMF to issue SDRs as a global reserve currency to replace the dollar, and then America will gradually depreciate the dollar to reduce the size of its enormous debt:

However, the Wall Street Journal argued in October that - while the IMF would like to be the world's central bank - the G20 is relegating it to a lesser role:

International Monetary Fund Managing Director Dominique Strauss-Kahn is using the IMF's annual meeting here to campaign for turning the fund into a kind of global central bank with at least $1 trillion for lending developing nations in a crisis.

But a very different reality is taking shape: The IMF is essentially being turned into the staff of the Group of 20, an organization of industrialized and developing nations that doesn't have a headquarters, staff or rules for membership. With the leaders of the G-20 effectively functioning as the board of directors of the global economy, they need the IMF's help to carry out their role.

Ellen Brown argues that the Bank for International Settlements (BIS) has been, and will continue to be, the real power behind the throne, even though the IMF seems to be gaining power.

I don't know who is right. But it does seem like America is losing its imperial status, and that global institutions such as the IMF, G20 and BIS are filling the void.

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